Why Warren Buffett wants IBM shares to languish…

Berkshire Hathaway’s common stock investments include IBM or International Business Machines Corp. Based on Warren Buffett’s annual letter to shareholders dated February 25, 2012, for FY2011, Berkshire Hathaway has a stake of 5.5% in IBM.

Given this 5.5% IBM stake, why did Warren Buffett said this in his annual letter: “We should wish for IBM’s stock price to languish throughout the five years.”

The answer lies in IBM’s repurchase program.

In Warren Buffett’s own words: “Today, IBM has 1.16 billion shares outstanding, of which we own about 63.9 million or 5.5%. Naturally, what happens to the company’s earnings over the next five years is of enormous importance to us. Beyond that, the company will likely spend $50 billion or so in those years to repurchase shares…

“Let’s do the math. If IBM’s stock price averages, say, $200 during the period, the company will acquire 250 million shares for its $50 billion. There would consequently be 910 million shares outstanding, and we would own about 7% of the company. If the stock conversely sells for an average of $300 during the five-year period, IBM will acquire only 167 million shares. That would leave about 990 million shares outstanding after five years, of which we would own 6.5%.

” If IBM were to earn, say, $20 billion in the fifth year, our share of those earnings would be a full $100 million greater under the ‘disappointing’ scenario of a lower stock price than they would have been at the higher price. At some later point our shares would be worth perhaps $1 1⁄2 billion more than if the ‘high-price’ repurchase scenario had taken place.

“The logic is simple: If you are going to be a net buyer of stocks in the future, either directly with your own money or indirectly (through your ownership of a company that is repurchasing shares), you are hurt when stocks rise. You benefit when stocks swoon. Emotions, however, too often complicate the matter: Most people, including those who will be net buyers in the future, take comfort in seeing stock prices advance. These shareholders resemble a commuter who rejoices after the price of gas increases, simply because his tank contains a day’s supply.”

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